Texas Taxes Cloud-Based Software Texting Service

Texas is one of many states beginning to tax software as a service. Known as SaaS, these new impositions of tax are still struggling with practical application. Software as a service typically includes a situation in which a software company develops software to be accessed via the internet. The software company then operates or hosts the website through which the software is accessed by customers online. It is important to note that customers do not possess or own the software; rather they pay for access to it online.

To understand the difference, let’s use the example of a video game. A user can purchase a game and access it remotely online. That would be considered software as a service. However, is the game allows users to download the program, that is not software as a service because the customer ultimately has possession of the software on his or her computer. The distinguishing feature of SaaS is that the user does not own or possess the software.

The type of SaaS addressed by Texas in a a recent letter ruling is one in which a customer uses a web-based dashboard application to receive and process data, translate and store messages, and create analytic reports for the customer’s use. The Taxpayer describes and markets their business as “a better, faster way to communicate with today’s customers.” By using a dashboard application, subscribing businesses communicate and interact with their customers via text and other types of mobile messaging channels. Customers are able to text questions, orders, etc. to the business directly. The Taxpayer reconfigures the incoming message from the customer and so that it can be displayed in English on the business’s dashboard application. Following that, custom or canned replies, or both, are reconfigured and sent back to the customer. Meanwhile the analytic services provided include the generation of reports on the number of requests per day, the categories of requests, and the average response times.

Texas finds this to be a taxable data processing service. The reasoning was that Taxpayer’s stored customers’ messages and information about the messages for subsequent retrieval. Section 151.0103 defines telecommunications services and expressly excludes data processing, including the storage of data or information for subsequent retrieval. However, section 151.0035 defines data processing as “word processing, data entry, data retrieval, data search, information compilation, and other computerized data and information storage or manipulation.” Consequently, the Department found that Taxpayer’s services were explicitly excluded by the communications services and included in data processing services, of which SaaS is a part. Therefore, they were subject to tax at the rate of 80% of the data processing service charges.

Of further importance is the fact that Texas found that data processing services, like the one at issue in this letter ruling, are not taxable as communication services. There appears to be a split amongst states when it comes to remotely accessed software. One group finds this to be a taxable communication service. Especially in an example like this, in which software facilitates texting communications, you can see why it might fall under that tax. However, other states, like Texas, tax software as a service, and software access falls under that. It will be interesting to see how states credit each other when the underlying transaction is taxed differently.

Finally, how will states deal with the issue of location of access. For example, if the access occurs primarily out of state, even though the billing address for that access is in Texas, is the transaction still subject to tax in Texas? Alternatively, what is the opposite is true? These and other questions will need to be addressed soon by states that have gone down the road of taxing remotely accessed software. Until then, Taxpayers could find themselves subjected to multiple taxation across states.

Jeanette Moffa is an associate attorney of the Law Offices of Moffa, Sutton, & Donnini, P.A. Ms. Moffa concentrates in the area of State and Local Taxation with a heavy emphasis on sales and use tax. In addition to Florida and multi-state sales and use tax issues, she also works on appellate administrative law cases. When she is not practicing law, she teaches English as an adjunct professor at Broward College. You can read more about Jeanette at her bio here.